The fallout from the Yahoo data breaches continues to illustrate how cyberattacks thrust companies into the competing roles of crime victim, regulatory enforcement target and civil litigant.

Yahoo, which is now known as Altaba, recently became the first public company to be fined ($35 million) by the Securities and Exchange Commission for filing statements that failed to disclose known data breaches. This is on top of the $80 million federal securities class action settlement that Yahoo reached in March 2018—the first of its kind based on a cyberattack. Shareholder derivative actions remain pending in state courts, and consumer data breach class actions have survived initial motions to dismiss and remain consolidated in California for pre-trial proceedings. At the other end of the spectrum, a federal judge has balked at the U.S. Department of Justice's (DOJ) request that a hacker-for-hire indicted in the Yahoo attacks be sentenced to eight years in prison for a digital crime spree that dates back to 2010.

The Yahoo Data Breaches

In December 2014, Yahoo's security team discovered that Russian hackers had obtained its "crown jewels"—the usernames, email addresses, phone numbers, birthdates, passwords and security questions/answers for at least 500 million Yahoo accounts. Within days of the discovery, according to the SEC, "members of Yahoo's senior management and legal teams received various internal reports from Yahoo's Chief Information Security Officer (CISO) stating that the theft of hundreds of millions of Yahoo users’ personal data had occurred." Yahoo's internal security team thereafter was aware that the same hackers were continuously targeting Yahoo's user database throughout 2015 and early 2016, and also received reports that Yahoo user credentials were for sale on the dark web.

In the summer of 2016, Yahoo was in negotiations with Verizon to sell its operating business. In response to due diligence questions about its history of data breaches, Yahoo gave Verizon a spreadsheet falsely representing that it was aware of only four minor breaches involving users’ personal information.  In June 2016, a new Yahoo CISO (hired in October 2015) concluded that Yahoo's entire database, including the personal data of its users, had likely been stolen by nation-state hackers and could be exposed on the dark web in the immediate future. At least one member of Yahoo's senior management was informed of this conclusion. Yahoo nonetheless failed to disclose this information to Verizon or the investing public. It instead filed the Verizon stock purchase agreement—containing an affirmative misrepresentation as to the non-existence of such breaches—as an exhibit to a July 25, 2016, Form 8-K, announcing the transaction. 

On September 22, 2016, Yahoo finally disclosed the 2014 data breach to Verizon and in a press release attached to a Form 8-K.  Yahoo's disclosure pegged the number of affected Yahoo users at 500 million.

The following day, Yahoo's stock price dropped by 3%, and it lost $1.3 billion in market capitalization. After Verizon declared the disclosure and data breach a "material adverse event" under the Stock Purchase Agreement, Yahoo agreed to reduce the purchase price by $350 million (a 7.25% reduction in price) and agreed to share liabilities and expenses relating to the breaches going forward.

Since September 2016, Yahoo has twice revised its data breach disclosure.  In December 2016, Yahoo disclosed that hackers had stolen data from 1 billion Yahoo users in August 2013, and had also forged cookies that would allow an intruder to access user accounts without supplying a valid password in 2015 and 2016. On March 1, 2017, Yahoo filed its 2016 Form 10-K, describing the 2014 hacking incident as having been committed by a "state-sponsored actor," and the August 2013 hacking incident by an "unauthorized third party."  As to the August 2013 incident, Yahoo stated that "we have not been able to identify the intrusion associated with this theft." Yahoo disclosed security incident expenses of $16 million ($5 million for forensics and $11 million for lawyers), and flatly stated: "The Company does not have cybersecurity liability insurance."

The same day, Yahoo's general counsel resigned as an independent committee of the Yahoo Board received an internal investigation report concluding that "[t]he 2014 Security Incident was not properly investigated and analyzed at the time, and the Company was not adequately advised with respect to the legal and business risks associated with the 2014 Security Incident." The internal investigation found that "senior executives and relevant legal staff were aware [in late 2014] that a state-sponsored actor had accessed certain user accounts by exploiting the Company's account management tool."

The report concluded that "failures in communication, management, inquiry and internal reporting contributed to the lack of proper comprehension and handling of the 2014 Security Incident." Yahoo's CEO, Marissa Mayer, also forfeited her annual bonus as a result of the report's findings.

On September 1, 2017, a California federal judge partially denied Yahoo's motion to dismiss the data breach class actions. Then, on October 3, 2017, Yahoo disclosed that all of its users (3 billion accounts) had likely been affected by the hacking activity that traces back to August 2013. During a subsequent hearing held in the consumer data breach class action, a Yahoo lawyer stated that the company had confirmed the new totals on October 2, 2017, based on further forensic investigation conducted in September 2017. That forensic investigation was prompted, Yahoo's counsel said, by recent information obtained from a third party about the scope of the August 2013 breach. As a result of the new disclosures, the federal judge granted the plaintiffs’ request to amend their complaint to add new allegations and causes of action, potentially including fraud claims and requests for punitive damages.

The SEC Breaks New Cybersecurity Ground

Just a month after issuing new interpretive guidance about public company disclosures of cyberattacks (see our Post and Alert), the SEC has now issued its first cease-and-desist order and penalty against a public company for failing to disclose known cyber incidents in its public filings. The SEC's administrative order alleges that Yahoo violated Sections 17(a)(2) & (3) of the Securities Act of 1933 and Section 13(a) of the Securities Exchange Act of 1934 and related rules when its senior executives discovered a massive data breach in December 2014, but failed to disclose it until after its July 2016 merger announcement with Verizon.

During that two-year window, Yahoo filed a number of reports and statements with the SEC that misled investors about Yahoo's cybersecurity history. For instance, in its 2014-2016 annual and quarterly reports, the SEC found that Yahoo included risk factor disclosures stating that the company "faced the risk" of potential future data breaches, “without disclosing that a massive data breach had in fact already occurred.”

Yahoo management's discussion and analysis of financial condition and results of operation (MD&A) was also misleading, because it "omitted known trends and uncertainties with regard to liquidity or net revenue presented by the 2014 breach." Knowing full well of the massive breach, Yahoo nonetheless filed a July 2016 proxy statement relating to its proposed sale to Verizon that falsely denied knowledge of any such massive breach. It also filed a stock purchase agreement that it knew contained a material misrepresentation as to the non-existence of the data breaches.

Despite being informed of the data breach within days of its discovery, Yahoo's legal and management team failed to properly investigate the breach and made no effort to disclose it to investors. As the SEC described the deficiency, "Yahoo senior management and relevant legal staff did not properly assess the scope, business impact, or legal implications of the breach, including how and where the breach should have been disclosed in Yahoo's public filings or whether the fact of the breach rendered, or would render, any statements made by Yahoo in its public filings to be misleading." Yahoo's in-house lawyers and management also did not share information with its auditors or outside counsel to assess disclosure obligations in public filings.

In announcing the penalty, SEC officials noted that Yahoo left "its investors totally in the dark about a massive data breach" for two years, and that "public companies should have controls and procedures in place to properly evaluate cyber incidents and disclose material information to investors." The SEC also noted that Yahoo must cooperate fully with its ongoing investigation, which may lead to penalties against individuals.

The First Hacker Faces Sentencing

Coincidentally, on the same day that the SEC announced its administrative order and penalty against Yahoo, one of the four hackers indicted for the Yahoo cyberattacks (and the only one in U.S. custody) appeared for sentencing before a U.S. District Judge in San Francisco. Karim Baratov, a 23-year-old hacker-for-hire, had been indicted in March 2017 for various computer hacking, economic espionage, and other offenses relating to the 2014 Yahoo intrusion.

His co-defendants, who remain in Russia, are two officers of the Russian Federal Security Service (FSB) and a Russian hacker who has been on the FBI's Cyber Most Wanted list since November 2013. The indictment alleges that the Russian intelligence officers used criminal hackers to execute the hacks on Yahoo's systems, and then to exploit some of that stolen information to hack into other accounts held by targeted individuals. 

Baratov is the small fish in the group. His role in the hacking conspiracy focused on gaining unauthorized access to non-Yahoo email accounts of individuals of interest identified through the Yahoo data harvest.  Unbeknownst to Baratov, he was doing the bidding of Russian intelligence officers, who did not disclose their identities to the hacker-for-hire. Baratov asked no questions in return for commissions paid on each account he compromised.

In November 2017, Baratov pled guilty to conspiracy to commit computer fraud and aggravated identity theft. He admitted that, between 2010 and 2017, he hacked into the webmail accounts of more than 11,000 victims, stole and sold the information contained in their email accounts, and provided his customers with ongoing access to those accounts. Baratov was indiscriminate in his hacking for hire, even hacking for a customer who appeared to engage in violence against targeted individuals for money. Between 2014 and 2016, he was paid by one of the Russian intelligence officers to hack into at least 80 webmail accounts of individuals of interest to Russian intelligence identified through the 2014 Yahoo incident. Baratov provided his handler with the contents of each account, plus ongoing access to the account.

The government is seeking eight years of imprisonment, arguing that Baratov "stole and provided his customers the keys to break into the private lives of targeted victims." In particular, the government cites the need to deter Baratov and other hackers from engaging in cybercrime-for-hire operations. The length of the sentence alone suggests that Baratov is not cooperating against other individuals. Baratov's lawyers have requested a sentence of no more than 45 months, stressing Baratov's unwitting involvement in the Yahoo attack as a proxy for Russian intelligence officers.

In a somewhat unusual move, the sentencing judge delayed sentencing and asked both parties to submit additional briefing discussing other hacking sentences. The judge expressed concern that the government's sentencing request was severe and that an eight-year term could create an "unwarranted sentencing disparity" with sentences imposed on other hackers.

The government is going to the mat for Baratov's victims.  On May 8, 2018, the government fired back in a supplemental sentencing memorandum that reaffirms its recommended sentence of 8 years of imprisonment. The memorandum contains an insightful summary of federal hacking sentences imposed on defendants, with similar records who engaged in similar conduct, between 2008 and 2018. The government surveys various types of hacking cases, from payment card breaches to botnets, banking Trojans and theft and exploitation of intimate images of victims.

The government points to U.S. Sentencing Guidelines Commission data showing that federal courts almost always have imposed sentences within the advisory Guidelines range on hackers who steal personal information and do not earn a government-sponsored sentence reduction (generally due to lack of cooperation in the government's investigation). The government also expands on the distinctions between different types of hacking conduct and how each should be viewed at sentencing. It focuses on Baratov's role as an indiscriminate hacker-for-hire, who targeted individuals chosen by his customers for comprehensive data theft and continuous surveillance. Considering all of the available data, the government presents a very persuasive argument that its recommended sentence of eight years of imprisonment is appropriate. Baratov's lawyers may now respond in writing, and sentencing is scheduled for May 29, 2018.

Lessons from the Yahoo Hacking Incidents and Responses

There are many lessons to be learned from Yahoo's cyber incident odyssey. Here are some of them:

The Criminal Conduct

• Cybercrime as a service is growing substantially.

• Nation-state cyber actors are using criminal hackers as proxies to attack private entities and individuals. In fact, the Yahoo fact pattern shows that the Russian intelligence services have been doing so since at least 2014.

• Cyber threat actors—from nation-states to lone wolves – are targeting enormous populations of individuals for cyber intrusions, with goals ranging from espionage to data theft/sale, to extortion.

• User credentials remain hacker gold, providing continued, unauthorized access to online accounts for virtually any targeted victim.

• Compromises of one online account (such as a Yahoo account) often lead to compromises of other accounts tied to targeted individuals. Credential sharing between accounts and the failure to employ multi-factor authentication makes these compromises very easy to execute.

The Incident Responses

• It's not so much about the breach, as it is about the cover up. Yahoo ran into trouble with the SEC, other regulators and civil litigants because it failed to disclose its data breaches in a reasonable amount of time. Yahoo's post-breach injuries were self-inflicted and could have been largely avoided if it had properly investigated, responded to, and disclosed the breaches in real time.

• SEC disclosures in particular must account for known incidents that could be viewed as material for securities law purposes.  Speaking in the future tense about potential incidents will no longer be sufficient when a company has actual knowledge of significant cyber incidents.

• Regulators are laying the foundation for ramped-up enforcement actions with real penalties. Like Uber with its recent FTC settlement, Yahoo received some leniency for being first in terms of the SEC's administrative order and penalty. The stage is now set and everyone is on notice of the type of conduct that will trigger an enforcement action. 

• Yahoo was roundly applauded for its outstanding cooperation with law enforcement agencies investigating the attacks. These investigations go nowhere without extensive victim involvement. Yahoo stepped up in that regard, and that seems to have helped with the SEC, at least.

• Lawyers must play a key role in the investigation and response to cyber incidents, and their jobs may depend on it. Cyber incident investigations are among the most complex types of investigations that exist. This is not an area for dabblers and rookies. Organizations need to hire in-house lawyers with actual experience and expertise in cybersecurity and cyber incident investigations.

• Senior executives need to become competent in handling the crisis of cyber incident response. Yahoo's senior executives knew of the breaches well before they were disclosed. Why the delay? And who made the decision not to disclose in a timely fashion?

• The failures of Yahoo's senior executives illustrate precisely why the board of directors now must play a critical role not just in proactive cybersecurity, but in overseeing the response to any major cyber incident. The board must check senior management when it makes the wrong call on incident disclosure.

The Litigation

• Securities fraud class actions may fare much better than consumer data breach class actions. The significant stock drop coupled with the clear misrepresentations about the material fact of a massive data breach created a strong securities class action that led to an $80 million settlement.  The lack of financial harm to consumers whose accounts were breached is not a problem for securities fraud plaintiffs.

• Consumer data breach class actions are more routinely going to reach the discovery phase. The days of early dismissals for lack of standing are disappearing quickly.  This change will make the proper internal investigation into incidents and each step of the response process much more critical.

• Although the jury is still out on how any particular federal judge will sentence a particular hacker, the data is trending in a very positive direction for victims. At least at the federal level, hacks focused on the exploitation of personal information are being met with stiff sentences in many cases. A hacker’s best hope is to earn government-sponsored sentencing reductions due to extensive cooperation. This trend should encourage hacking victims (organizations and individuals alike) to report these crimes to federal law enforcement and to cooperate in the investigation and prosecution of the cybercriminals who attack them.

• Even if a particular judge ultimately goes south on a government-requested hacking sentence, the DOJ's willingness to fight hard for a substantial sentence in cases such as this one sends a strong signal to the private sector that victims will be taken seriously and protected if they work with the law enforcement community to combat significant cybercrime activity.